United States:
As Interest In Blockchain Technology Grows, So Do Attempts At Guidance And Regulation

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In 2018, the number of blockchain-enabled projects increased
sharply as established companies sought to apply distributed ledger
technology to their existing business models and startups developed
new and disruptive models employing this technology. Projects have
already been implemented in the financial services, insurance and
supply chain fields, and important developments are taking place in
blockchain-based identity services. As use of blockchain technology
has expanded, regulators from a range of geographic and legal
jurisdictions have struggled to apply laws and regulations that
were drafted for business activities involving a clearly
identifiable service "provider" to autonomous,
decentralized platforms where the actual "provider" is
not evident.

For example, regulators responsible for securities, commodities,
anti-money laundering (AML) and privacy all wrestled with
blockchain issues in 2018. Often, the cases brought and guidance
offered raised more questions than they answered. Any company
implementing or investing in blockchain technology will need to pay
close attention to this evolving regulatory landscape.

Securities Law

A number of noteworthy legal developments relating to
cryptocurrencies emerged in 2018, providing incremental clarity for
participants in this emerging area of securities law.

Digital Tokens. On
June 14, 2018, William H. Hinman, director of the Securities and
Exchange Commission's (SEC) Division of Corporation Finance,
suggested that digital tokens like Ether might initially be defined
as "investment contracts" (and thus as
"securities" under the federal securities laws) but that
their networks and decentralized structures could evolve to a point
where the tokens no longer constituted securities.

FinHub. On October
18, 2018, the SEC launched the Strategic Hub for Innovation and
Financial Technology (FinHub), which was designed to provide a way
for technologists and their advisers "to engage with SEC
staff," according to Valerie A. Szczepanik, the SEC's
senior adviser for digital assets and innovation. The creation of
FinHub suggests that the SEC is willing to work with developers
regarding compliance rather than approach the issue solely from an
enforcement perspective.

SEC Settlements. On
November 16, 2018, the SEC announced that CarrierEQ Inc. (aka
AirFox) and Paragon Coin Inc., which sold digital tokens in initial
coin offerings (ICOs), agreed to pay penalties, register under
Section 12(g) of the Securities Exchange Act and offer voluntary
rescission rights to investors. These settlements may provide a
road map to compliance for those who have already engaged in
ICOs.

SECv. Blockvest, LLC. On
November 27, 2018, Judge Gonzalo P. Curiel of the U.S. District
Court for the Southern District of California denied the SEC's
request for a preliminary injunction against a company that had
engaged in an ICO. Judge Curiel concluded that the SEC had not
established that the Blockvest tokens at issue were securities
because there were disputed facts under the U.S. Supreme Court
decision SEC v. W.J. Howey Co.'s "investment of
money" and "expectation of profits" test prongs.
This case may prove to be significant in that the court suggested
the Howey test may not be met.

SEC Guidance. On
December 12, 2018, the SEC announced that it is developing guidance
for cryptocurrencies that it hopes to publish in early 2019. The
guidance is intended to help determine if a digital asset is a
security. If it is, the guidance would detail what a business
should do to comply with securities regulations. (See "
SEC Continues Steady Progress With Regulatory, Enforcement
Goals.")

Token Taxonomy Act.
On December 20, 2018, Reps. Warren Davidson, R-Ohio, and Darren
Soto, D-Fla., introduced the Token Taxonomy Act, which seeks, in
part, to clarify that securities laws would not apply to
cryptocurrencies once they become a fully functioning network.
Although we do not expect that this bill will be passed, it comes
after a year of various congressional hearings on how current
regulations apply to blockchain technology. We anticipate that
Congress will remain focused on this issue in 2019.

FinCEN

Cryptocurrencies also have been the subject of increasing focus
by the Department of the Treasury's Financial Crimes
Enforcement Network (FinCEN), which exercises AML regulatory
functions. Dating back to 2013, FinCEN has issued several rounds of
guidance on the application of AML requirements to businesses
performing certain functions or providing certain services related
to cryptocurrencies. In 2018, FinCEN took additional steps toward
answering outstanding questions, including in the context of ICOs.
We expect FinCEN to issue further clarifying guidance in 2019.

In a February 2018 letter responding to questions from Sen. Ron
Wyden, D-Ore., the Treasury Department took the position that
"[g]enerally, under existing regulations and interpretations,
a developer that sells convertible virtual currency, including in
the form of ICO coins or tokens, in exchange for another type of
value that substitutes for currency is a money transmitter"
and is therefore subject to corresponding AML requirements for
money services businesses. The Treasury Department, however, noted
that ICOs vary in structure, and there could be circumstances in
which AML requirements imposed by the SEC or Commodity Futures
Trading Commission (CFTC) would apply.

FinCEN Director Kenneth A. Blanco echoed this view in an August
2018 speech at the Chicago-Kent Block (Legal) Tech Conference,
stating that "[w]hile ICO arrangements vary and, depending on
their structure, may be subject to different authorities, one fact
remains absolute: FinCEN, and our partners at the SEC and CFTC,
expect businesses involved in ICOs to meet all of their AML/CFT
obligations." It is notable that Blanco did not specifically
reassert the view in the Wyden letter that companies conducting
ICOs generally are money transmitters. The failure to do so raises
some questions as to whether FinCEN viewed the reaffirmation as
unnecessary or was backtracking on the more categorical
position.

FinCEN also is working with foreign governments to address risks
related to virtual currencies, including through the Egmont Group
of Financial Intelligence Units and through the Financial Action
Task Force. Treasury Under Secretary Sigal P. Mandelker has stated
that, as part of this effort, the Treasury Department is
"encouraging our international partners to take urgent action
to strengthen their AML/CFT frameworks for virtual currency and
other related digital asset activities." We expect that
efforts to align global approaches to cryptocurrencies will
increase in 2019.

Applying GDPR to Blockchain Platforms

Blockchain technology has the potential to revolutionize how
personal information is stored and processed. However, many of its
fundamental concepts clash with the requirements of the European
Union's General Data Protection Regulation (GDPR) requirements.
(See "
European Data Protection and Cybersecurity in 2019.")

In 2018, EU regulators began to focus on this issue, with the
French supervisory authority, the Commission Nationale de
l'Informatique et des Libertés (CNIL), and the EU
Blockchain Observatory and Forum (the Observatory) publishing
initial reflections on this matter but offering little definitive
guidance. For example, the reports acknowledged that with a
blockchain platform, it is difficult to determine the identity of
the data controller (which determines the purpose and means of
processing personal data) and the data processor, since in many
blockchain platforms, multiple nodes hold the data without any
single controller or processor. The reports acknowledge this issue
but simply conclude it must be resolved on a case-by-case
basis.

Similarly, a cornerstone of blockchain technology is the use of
hashing to cloak and represent specific data sets. While many see
these hashes as anonymous and therefore not subject to privacy
regulations, the GDPR narrowly limits anonymization to cases where
it is impossible to reverse the encryption process or link the
encrypted data to an individual by studying usage patterns. Hashes
may not meet this definition. Here, too, the reports acknowledge
the issue but leave it to case-by-case analysis.

The GDPR also provides individuals with a series of rights,
including a right in certain cases to have their data deleted
(known as the right to be forgotten). This principle conflicts with
the immutability of a blockchain, where once data is stored, it
cannot be erased or modified. Furthermore, it is not clear who
enforces this right if a data controller cannot readily be
identified. The CNIL's preliminary suggestion is that
encryption coupled with the destruction of the encryption key might
satisfy this requirement.

The right to be forgotten principle conflicts with the
immutability of a blockchain, where once data is stored, it cannot
be erased or modified.

Although the reports signal that regulators are beginning to
focus on this issue, they may not issue any meaningful guidance for
some time. Developers of blockchain platforms will need to glean
what they can from these initial reports and keep compliance with
the GDPR and other privacy laws in mind during the development
process.

CFTC/Derivatives Law

While the CFTC has actively used its enforcement authority to
police fraud and protect retail customers in the cryptocurrency
markets, its formal guidance on how the Commodity Exchange Act
(CEA) applies to the blockchain and cryptocurrency space has been
fairly sparse. Aside from a few short releases, the CFTC's
primary guidance in this area is its December 2017 proposed
interpretation of what constitutes "actual delivery" in
retail cryptocurrency transactions. (The CFTC regulates leveraged
or margined cryptocurrency transactions involving retail customers
where the cryptocurrency is not "actually delivered"
within 28 days.)

Near the end of 2018, the CFTC demonstrated its continuing
interest in cryptocurrencies and their relationship to derivatives
markets by requesting public input (RFI) on Ether and the Ethereum
network. The RFI illustrates that the CFTC is relying on market
participants and the public to help inform its understanding of,
among other areas, how cryptocurrencies and their networks operate,
the technology they depend on, their governance structures, the
purposes for which they are used, and their liquidity and
susceptibility to manipulation. This information is relevant to the
CFTC in deciding how to police cryptocurrency fraud and regulate
derivatives contracts based on cryptocurrencies. It is evident that
the CFTC also is looking beyond cryptocurrencies and closely
monitoring the development of decentralized systems generally. For
example, LabCFTC, the agency's initiative to engage with the
fintech innovation community, recently issued a primer on smart
contracts to explain the technology and related risks and
challenges.

Given the CFTC's interest in blockchain applications, one
area to watch in 2019 will be the CFTC's regulatory approach to
emerging smart contracts. On October 16, 2018, Commissioner Brian
D. Quintenz stated at the 38th Annual GITEX Technology Week
Conference that the CFTC's existing regulatory authority may
apply to smart contracts, encouraging innovators to engage with the
commission but also focusing on potential liability for coders
whose smart contracts facilitate trading in products subject to
CFTC jurisdiction, such as options entered into with retail
customers. The SEC recently settled an enforcement action against
Zachary Coburn, the founder of EtherDelta — a smart
contract-based market platform for trading digital tokens —
for causing it to operate as an unregistered securities exchange.
The CFTC may not be far behind in pursuing smart contract
applications that may not comply with the CEA or CFTC
regulations.

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